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Investment Overview for Gap Inc. (NYSE:GPS)

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Latest Earnings Q4'19

Gap reported a mixed performance for the fourth quarter (ending January). Overall, same-store sales were down 1% during the quarter, compared to negative 1% in the year-ago quarter. Comparable sales for Gap Global and Banana Republic slid 5% and 1% respectively while Old Navy’s comparable sales remained flat. Net sales of the company increased by 1% y-o-y to $4.7 billion while the company reported loss per share was $0.49, mainly due to an impairment charge of $296 million related to the store assets and operating lease assets of the company’s flagship stores.

Impact Of COVID-19 outbreak

Gap has temporarily shuttered its stores in North America and Europe as a result of continued measures to help slow the spread of COVID-19. Moreover, the company has decided to furlough the majority of its store teams in the United States and Canada and is also planning to reduce headcount across its corporate functions around the world in a bid to save costs. In its Q4 2019 earnings (ending January), Gap anticipated its Q1 2020 results to be negatively impacted by approximately $100 million in sales due to the coronavirus outbreak. However, the impact is likely to be much higher than anticipated earlier.

Gap Inc Cancels Plan to separate the Company into two independent publicly-traded companies

Gap Inc announced its plan to separate Gap Inc. into two independent publicly traded companies - an independent Old Navy, and a yet-to-be christened new company ("NewCo") that would include Gap brand, Athleta, Banana Republic, Intermix and Hill City. However, the company has canceled its proposed spin-off and will continue to exist as a single entity.

Strength of Old Navy

The brand delivered a mixed performance in 2019, with the brand registering a negative comps growth of 2%. However, the store traffic at Old Navy continued to outpace industry trends, and its online segment saw a meaningful acceleration, as the brand continued to outperform its peers. The fact that the brand's merchandise tends to be skewed towards the affordable segment has worked in its favor. Seeing its impressive performance, Gap has accelerated Old Navy store openings, with over 80 opened in FY 2018, and added another 77 stores in FY 2019. The management noted that new store performance is beating expectations, and remodels are outperforming the fleet by an average spread of five comp points. The company feels the brand remains under-penetrated when compared with its peers, and hence, plans to increase further its store count in the coming years, which should help to increase the revenues.

Popularity Of Athleta

According to the NPD group, the activewear industry is the "primary driver of growth opportunity" for the apparel industry. The report stated that 24 percent of total apparel sales are made in the athleisure segment. Hence, it is no surprise that Gap's Athleta brand has been performing well, in fact, at a much faster rate than that of the industry. The brand had another strong year, and we expect the momentum to continue through in FY 2020. In line with its growth strategy detailed during FY 2019, the company expects store openings to be focused on Athleta and Old Navy, with closures weighted toward Gap and the Banana Republic.
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Old Navy Stores EBITDA Margin

Old Navy Stores EBITDA Margin: EBITDA margins Old Navy Stores declined from 18.4% in 2010 to 14.4% in 2011 due to a sudden rise in cotton costs owing to floods in major cotton-producing areas, and excessive promotional activities in domestic operations. The margins rebounded to 16.7% in 2012 with lower cotton prices and better product mix. This improvement continued in 2013 as margins increased slightly to 17.3% with better expense leverage. In 2014, weighed down by heavy promotions, Old Navy Stores EBITDA Margin declined to 16.7% and they further shrunk to 13.9% in 2015. The declining trend continued in 2016 when the metric fell to 12%. This trend reversed in 2017, as a result of higher sales of full-priced items, and increased digital sales, with the metric reaching 13.4%. This figure declined to 12.2% in 2018 before plunging to 7.3% in 2019 as a result of an increase in operating expenses led by separation-related costs and global flagship impairment charges. Going forward, we expect Old Navy's margins to continue to show an improvement, albeit slowly, as a result of greater full-price sales, and an improvement in online revenues

Gap Store & Internet Revenue per Square Foot

Gap Store & Internet Revenue per Square Foot: Gap store revenue per square feet increased consistently from $412 in 2009 to $484 in 2013 driven by the consolidation of under-performing stores, online revenue growth, and strong customer response to the brand's products. However, the figure declined to $466 in 2014, $455 in 2015, and $448 in 2016 as buyers across the industry scaled back their spending on premium basic products and spent on fast fashion brands instead. Improved retail conditions in the second half of 2017, as well as the growth of smaller brands - Athleta, Intermix, GapKids, and babyGap, rise in online revenues, development of the omnichannel platform, and store consolidation, resulting in an improvement in the metric in 2017 to $465 and further to $477 in 2019. We project the figure to reach $520 by the end of our forecast period.
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Gap is a global specialty retailer offering clothing, accessories, and personal care products for men, women, and children. It markets its products under the Gap, Old Navy, Banana Republic, Athleta, GapKids, babyGap, and Intermix brands.

Gap operates stores in North America and several countries in Europe and Asia. It is one of the few U.S. apparel retailers who have a decent international presence. The company also sells its products online through web-based stores for each of its brands. The company has recently changed its reporting structure due to its adoption of omnichannel retailing. It no longer reports separate e-commerce revenues but includes them in individual brands' revenues. In addition to this, Gap has franchise agreements with unaffiliated franchisees to operate Gap, Old Navy, and Banana Republic stores in many countries.

The retailer operates three different brands for three main demographics: Old Navy for cost and fashion-conscious teenagers, Gap for young adults, and Banana Republic for more affluent and relatively older customers.

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Development of omni-channel platform

An omnichannel platform enables retailers to engage customers irrespective of the shopping channel they prefer. A while back, Gap Inc. launched its ship-from-store service, which allows the fulfillment of online orders through store inventories. This service not only enables the company to offer a greater variety of merchandise over the Internet but also helps it improve delivery responsiveness and store traffic. A couple of years back, Gap Inc. launched “find in store” and “reserve in store” services to enhance its customer service and integrate the digital and store channel. The “find in store” function informs the customers where to find the nearest stores and the “reserve in store” service allows them to reserve up to five items online to try in stores. Since buying clothes is a personal experience and online shopping provides convenience, this offers customers the best of both channels. Encouraged by the pleasing response, the company expanded its “reserve in store” to all Gap Stores in the U.S. in 2014. In addition, it began testing a new order in-store capability later in the year, which gives customers instant access to expanded merchandise offerings over the Internet.

Online retail sales in the U.S. have grown at a rapid pace over the past several years, thanks to growing internet usage in the country. Internet penetration in the U.S. has gone up from 44% in 2000 to 89% currently. Furthermore, facilitated by the convenience of constant access, 92% of teens today go online daily, including 24% who are online constantly, according to a study conducted by Pew Research Center. Over half of the teens (aged 13 to 17 years) go online several times a day, aided by the presence of smartphones, which is available to nearly three-quarters of teens. Smartphone usage will only increase in the future, and this will likely result in a steady rise in online sales. This is evidenced by research that predicts online apparel sales in the US to increase its revenue from $63 billion in 2015 to $195 billion by 2024 .

Efforts to gain market share in the U.S.

While Gap Inc. is consolidating its main brand networks in North America, it is looking at other ways to gain share in the U.S. apparel market. The retailer is relying on smaller brands for this purpose, such as Athleta, Intermix, GapKids, and babyGap, to grow its business in North America. Through Athleta, Gap Inc. offers performance-driven sports apparel and footwear for women. In line with its growth strategy detailed during FY 2019, the company expects store openings to be focused on Athleta and Old Navy, with closures weighted toward Gap and the Banana Republic.

Gap's targeted international expansion

International expansion is one of the key long-term strategies of Gap. The company is particularly focused on emerging economies such as China, which has become the second-largest apparel market in the world with a booming middle class, rising disposable income, and growing urbanization. The company opened 38 Gap stores in Asia in 2014, 39 in 2015, 27 in 2016, 52 in 2017, 34 in 2018, and added another 26 in 2019 with most located in China.

Optimizing Store Fleet

Gap Inc. has continued the process of optimizing its store count, including reducing its exposure to low productivity stores. The company has also seen an opportunity for increasing the store count of Athleta, Old Navy, and the factory and outlet expressions at the Banana Republic and Gap. Consequently, in FY 2019, the company opened 189 company-operated stores, largely Old Navy and Athleta, while closing 177 stores, primarily Gap and Banana Republic.

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